4 property investment tax mistakes to avoid

The end of the financial year has now come and gone but investors still need to plan for the year ahead.

Some investors look forward to this, while others try to ignore it for as long as possible.

Why is that? 

In my experience, those investors who file their tax returns sooner rather than later not only understand what they can claim and what they cannot, they also have professionals to assist them.

On the other hand, investors who think that burying their head in the sand will be a useful strategy are generally the ones who don't understand the system.

And when it comes to tax that can be a dangerous situation to be in.

No one wants the Tax Office knocking on their door (not literally) asking to investigate their books, do they?

In fact, there are a number of common property investment mistakes that can easily be avoided at this time of year.

Let's take a look at four of them.

1. Land tax liability 

In days gone by it was common for investors to buy in locations where they believed they felt the understood the market.

And that was generally in their own backyard.

But today borderless investing is a strategy employed by sophisticated investors to capitalise on different market cycles.

Plus, it also helps to reduce land tax liability.

The thing is you're not subject to land tax until you exceed each State's threshold for the unimproved land value of your rental properties.

Therefore, there are some tax benefits to spreading your investments in different major capital city property markets.

2. Not charging market rent to your mates

Some property investors believe it's a wise idea to rent their properties to friends or relatives.

They think that will mean that they're more likely to look after the property, plus they won't need a property manager.

In my opinion, that's not the case, but the main problem with this "strategy" is that they often don't charge market rent. 

Instead they rent their property for "mates rates". 

Not only can this be self-defeating if the property is negatively geared, it could cause you problems in the tax department, too.

Under taxation legislation, deductions are permissible as long as the property's rent was at a "market" level.

Any “mates rates” will require you to apportion all expenses and effectively discount your total allowable deductions.

The tax rules still allow some small discounting if it reflects savings in your costs without jeopardising your deductions.

This can include savings to your costs if your tenant pays by automatic debit and undertakes small repairs and maintenance.

I would strongly suggest you retain professional property management as this service ensures you are legally managing your property and it keeps your tenant honest.

The agent also helps you understand the market to ensure maximum rental yields, the best tenant as well as minimises potential issues with the upkeep of the property.

3. Not claiming depreciation

Another common property investment tax mistake is not claiming depreciation.

Some investors are simply uneducated on the benefits of claiming depreciation to improve their cash flow. 

Depreciation can be claimed in two broad categories – being on the building and secondly on plant and equipment (although the latter has seen some recent changes to plant and equipment depreciation).

However, others try to circumvent the Capital Gains Tax (CGT) system by not claiming depreciation because they don't want to reduce their cost base when they sell.

The thing is, under taxation legislation, when you sell a property you need to add back building depreciation to determine the capital gain (or loss).

Along the way you claim these costs at your marginal tax rate but on sale you get the CGT 50 per cent discount so you pay tax on the discounted portion.

That means you are much better off, even before considering the time value of money or the fact that you may not sell.

Therefore, it makes no sense not to claim what you're entitled to, which can help you hold your properties for the long-term by improving your cash flow.

4. Interest rate worries

One of the certainties in life is that there will be headlines about interest rates. 

One day there are forecasts that rates are going up and the next they're on the way down.

However, this type of media speculation does little but worry some investors.

And this worry leads to some people off-loading their investment properties because they're scared of what "might happen" with rates in the future.

However, unless they've over-extended themselves financially to start off with, rate rises should not be  a problem.

You see.. rates generally never increase rapidly.

And when interest rates do start to rise it usually means that inflation is increasing and that means that property prices and rents have risen to create this inflation meaning you’re already ahead.

So, investors need to save their worry for when there is something to worry about and not jump at interest rate shadows.

Taking on debt allows you to leverage and it is the increased asset base and the compound growth that delivers wealth.

The bottom line on tax... 

The ability to hold investment grade properties over the long-term is one of the keys to financial success.

Smart property investors also educate themselves on allowable taxation deductions, which admittedly can change from time to time.

They also ensure they have experts on their side to guide them and to provide them with the information they need to make the most profitable decisions.

That way their chances of making any property investment tax mistakes are very slim indeed.

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Disclaimer

This article is general information only and is intended as educational material. Metropole Wealth Advisory nor its associated or related entitles, directors, officers or employees intend this material to be advice either actual or implied. You should not act on any of the above without first seeking specific advice taking into account your circumstances and objectives. 

About Ken Raiss Ken is director of Metropole Wealth Advisory and gives strategic expert advice to property investors, professionals and business owners. He is in a unique position to blend his skills of accounting, wealth advisory, property investing, financial planning and small business. View his articles